Question on Inventory Write Down (3 statements)
Hello,
Just wanted some insights in the treatment of inventory write down.
The question is "How does an inventory write down of $10 affect the financial statement?"
Here was my thought process and I am not sure if I am correct.
I/S
($10mm) write down can be treated as COGS, lowering taxable income by ($10mm).
Assuming tax rate of 40%, this translates to NI of ($6)
Then on CFS, you add back the 10mm as this is a non-cash expense (like how you would treat D&A).
But then in book basis, you were able to use ($10mm) to save taxes but in cash tax basis, because the inventory wasn't sold, you cannot use the inventory write down to lower your pretax income. Which creates a DTL of (4mm).
So CFO is essentially 0.
B/S
Asset: Inventory ($10mm)
Liability: DTL ($4mm)
Retained Earnings ($6mm)
I am not sure if this is correct. I know in PP&E write down scenario it would create a DTA because of lower D&A expense, but unsure how inventory write down is treated.
Also, on the CFO portion of CFS, would this ($10mm) of less inventory be part of the operating net working capital section as lower net working capital as opposed to adding back because it was non-cash expense (like D&A)?
Would love some help / insight.
Thanks!
bump
Correct.
I would treat it the same as you treat most non-cash expenses (e.g. D&A). Your thoughts regarding the relationship between the IS, BS and CFS check out to me. However I disagree with your assumption regarding taxes and your math there. For simplicity I would assume that any ($10mm) non-cash expense would result in cash tax implications for that same period.
Whether or not a DTA or DTL is recorded has nothing to do with if the expense was cash or not, but rather to do with when cash taxes are paid relative to the period in which they were owed.
For a ($10mm) non-cash write down of just about any kind, I would assume that results in ($10mm) pre-tax NI, and ($6mm) NI after taxes (40% taxes). That results in ($6mm) to your retained earnings. Considering your CFO top line NI will start at ($6mm) + $10mm non-cash write down will get you to $4mm CFO which Is added to cash to bring you to +$4mm cash + ($10mm) write down = liab + ($6mm)RE.
From what I understand the inventroy write down is booked as cogs and therefore an adjustment in working capital if small enough, but if it's material it would be a separate line item
OP is right. Might be some small nuances but interview questions wouldn't get more complicated than what you just answered.
Got it - thank you. So just to reiterate - it won't lead to 4mm increase in cash but rather a 4mm increase in DTL.
On the CFS would 10mm inventory write down be treated like 10mm cash add back since it was a non-cash charge, or would it be (Increase) / Decrease in Inventory line?
I know it makes no difference, but just wanted to know the small nuance there.
Hey just one thing though, if I think about this now, the B/S doesn't balance.
Asset:
Inventory -10
L+SE:
DTL +4
RE: -6
Would appreciate if you could provide some color. Getting confused as I go down further in the rabbit hole
DTL should be negative 4. (Or positive 4 if you put it as DTA)
Asset side: Inventory -10 DTA +4
L&E side: RE - 6
I am little confused about this - thanks for the reply.
I am assuming this is DTL because on cash tax basis, you cannot apply write-down of the inventory to the pretax income until it is sold. So amount of tax you paid in cash basis is no change.
However for book purpose, you write inventory down by $10mm and this becomes cogs. So your pretax income decreases by 10mm allowing you to get tax breaks of 4mm. But this isn't this 4mm tax that you have to eventually pay when you sell the inventory. So isn't that a DTL?
Unsure how
1. It can be either DTA or DTL
2. How can DTL be a negative number?
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